Question

Holtzman Clothiers's stock currently sells for $32 a share. It just paid a dividend of $1.5 a share (i.e., D₀ = $1.5). The dividend is expected to grow at a constant rate of 8% a year.

1. What stock price is expected 1 year from now? Round your answer to two decimal places.
   $
   
2. What is the required rate of return? Round your answer to two decimal places. Do not round your intermediate calculations.

Answer 1

Part (b)

Required rate of return is computed using the equation given below-

P₀ = D₁ / (r - g)

r - g = D₁ / P₀

   r = (D₁ / P₀) + g

   = ($1.62/ $32) + 0.08

   = 0.050625 + 0.08

   = 0.1306 or 13.06%

Hence, the required rate of return is 13.06%.

Working note-

D₁ = D₀ × (1 + g)

   = $1.50 × (1 + 0.08)

   = $1.62   

Part (a)

P₁ = D₂ / (r - g)

   = $1.7496 / (0.1306 - 0.08)

   = $1.7496 / 0.0506

   = $34.58   

Hence, the expected stock price 1 year from now is $34.58.

Working note-

D₂ = D₁ × (1 + g)

   = $1.62 × (1 + 0.08)

   = $1.7496   

Where,

P₀ = Current stock price.

D₀ = Last paid dividend.

D₁ = Expected dividend in the next year.

D₂ = Expected dividend in the second year from now.

P₁ = Expected price of the stock in the next year

r = Required rate of return

g = Growth rate